A golden opportunity for Europe and you

Commentary: The euro zone has one shot at a safe financial system

NEW YORK (MarketWatch) — First, a little respect where respect is due.

Back on Sept. 20, this column offered rare investing advice. It was “short the euro and make a buck.” That day, the euro was already a low $1.37. But the move played out in the short term: the euro dropped to $1.32 on Oct. 4 and now in the long term, even in the midst of Monday’s rally, the euro was at $1.33, a decline of 2.5%. Read column on the euro-dollar short.

Reuters

The euro

The thought behind the trade was that the great euro zone had been bumbling and stumbling. It had known of the sovereign debt issues of Greece, Italy, Ireland and Spain for more than two years and still hadn’t come up with a plan to bring confidence back to the markets.

That’s pretty much still the competency for the region. It wouldn’t matter to us except that Europe still devours 27% of U.S. exports. So, yes, the great nations of Europe can still throw the U.S. economy into the tank.

They also could save themselves and the world too. Europe, like the United States in 2008, is at a crossroads. Crises are no fun, but they do present politicians and regulators an opportunity to do more than just rescue and repair. Everything is on the table whether they acknowledge it or not.

So what’s the magic bullet? Break up the banks.

Record yields in European bond auctions

(4:52)

Italy and Belgium fared better in debt sales Monday than had been feared as market sentiment improved, but still had to pay euro-era high yields to lure buyers, Stephen Fidler reports on Markets Hub. Photo: AFP / Getty Images.

If you understand anything at all about the euro zone crisis, you should know that the real conflict is not between have and have-not nations. It’s not about pensions. It’s not about taxes or spending. It’s about banks and shadow banks that allowed all of those players to run up massive debt during the last decade.

These are the buy-side banks that underwrote, bought and sold all of the debt and derivatives. They’re the ones with the counterparty exposure and lack of reserves. If they don’t hold, say, Italian debt, then they have a lending relationship with a pension fund or another bank that does. You see the problem: it was garbage in, garbage out. Now everything stinks.

The banks are the ones that need the bailout. They’re going to need it from taxpayers. The ultimate package will be bigger than TARP, bigger than any bailout the world has seen.

So, how would breaking up the banks help? First it would limit the damage. Not every bank would make the mistakes of the giants that roam the continent today.

Second, smaller banking would create more competition, and perhaps better credit standards. Today’s too-big-to-fail banks have little margin for error. They dominate the landscape. When they stock up on Italian bonds, they put the economies at risk.

Smaller banks would also limit influence of big finance in Europe. Banks pushed hard for the euro zone because they saw it as greasing their way to cross-border expansion. And it did.

The politicians did little to stop that expansion in the name of free trade and free markets. It was a policy that worked as long as bubbles were expanding and everyone thought they were getting rich.

And for Germany, France and Italy, having big national banks gave them clout on a global stage that was dominated by financial power.

Reuters

An Italian flag waves in front of the Montecitorio palace before the start of a finances vote in downtown Rome November 8, 2011.

Of course, none of that matters now. The bigger the bank, the worse the headache for politicians who must now convince voters to cough up taxes to fund bailouts.

Breaking up the banks in exchange for government help would be a nice marriage of rescue and rehabilitation. A big bailout would bring confidence to the markets. Smaller banks would help protect against crises of this sort happening again.

The bad news for Europe and the world, and the good news for you as an investor, is that it’s not going to happen. The same indecision and fighting that have thwarted the euro zone so far are going to continue. The banks won’t be broken up. They’ll be saved as is, and it will cost a lot.

A smart investor would stay away from these banks. He or she would try look for overvalued asset management firms. They’d probably keep cool on their U.S. counterparts such as Citigroup Inc.
C, +1.85%
and J.P. Morgan Chase & Co.
JPM, +1.25%
which are both big and present in Europe and could see some fallout.

Of course, it’s not any fun to bet against the misfortunes and missteps of the euro zone. But investing isn’t a game of sympathy, it’s more like football: if the running game is working, you’d be foolish to throw a pass.

Until Europe shows it can stop the run, investors should keep pounding the ball.

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